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What debt can my business afford?

What debt can my business afford?

Debt is often perceived negatively by entrepreneurs as it carries some social stigma. But for a healthy business to borrow money to expand its operations, it can be a booster of growth. However, one needs to understand how much debt a company can take on and still remain financially healthy. 

Debt affordability refers to a company's ability to take on and manage new debt without putting itself at financial risk. This implies evaluating several factors such as the company's current financial situation, its future cash flow projections, and its overall creditworthiness.

Let's start with the current financial situation. To simplify, businesses can use a few simple financial metrics, called ratios, such as their debt service coverage (DSCR), debt-to-equity or debt-to-total assets to test their ability level of indebtedness and ability to take on a new loan. In particular, the DSCR shows investors whether a company has enough income to pay its debts. Indeed, it compares a company's total debt obligations (including principal repayments and some capital lease agreements) to its operating income (EBITDA). 

Secondly, for medium to long-term loans, businesses are advised to develop financial projections of their future income and cash flow. This involves forecasting how much money the company is likely to bring in on the back of the investment and how much it will need to pay out in the future. By doing this, businesses can get a better idea of whether they will have enough money coming in to cover their debt payments, as well as any other expenses they may have. It is important to stress test those projections by assuming a change in various key assumptions and observe how the projected revenue and cash flow vary in consequence. 

Finally, an important factor to consider when determining debt affordability is a company's creditworthiness. This will indeed influence the pricing of your loan or the interest rate charged. Companies with good credit scores and a history of sound financial performance and debt repayment are often considered more creditworthy and therefore offered better terms. 

👉 So how do I assess debt affordability? 

Pumpkn.io provides a series of simple tools and insights for you to assess your debt affordability. Firstly, on your financial dashboard, we provide you with xx ratios which are colour-coded (red to green). To bring those ratios into green, we will suggest actions that you can add to your to-do list and insights that you can discuss with your pumpkn.io coach. 

Secondly, in the Apply for funding, access a debt affordability calculator. Based on the recorded income and cashflow, the tool helps your quantify the amount of debt you can afford depending on the loan duration and interest rate.